After interviewing hundreds of people the president’s Financial Crisis Inquiry Commission (a month late) has released its mammoth report on the causes of the financial crisis and arrived at what I think can only be considered a cop-out: everybody’s to blame—you, me, Republicans, Democrats, the Fed, regulators, Congress, bankers, consumers, foreign investors, everybody. Such a finding provides no clear guidelines for action. It is oracular rather than analytic.
The minority report finds ten causes of the crisis:
- Credit bubble
- Housing bubble
- Nontraditional mortgages
- Credit ratings and securitization
- Financial institutions concentrated correlated risk
- Leverage and liquidity risk
- Risk of contagion
- Common shock
- Financial shock and panic
- Financial crisis causes economic crisis
The short version is that regulatory error (not too much or too little regulation but the wrong regulation) compounded by mammoth overseas capital flows were the smoking gun in the financial crisis. IMO the most significant finding in the minority report is that it absolves the Community Reinvestment Act and the repeal of Glass-Steagall from blame. The former is an article of faith among many on the right while the latter has much the same role for the left.
Mish Shedlock has an even terser explanation, assigning just three causes:
The actual cause of the financial crisis is easy to explain.
- Loose monetary policies at the Fed
- Fractional Reserve Lending
- Congress willing to spend more money that it takes in
Had there not been Fractional Reserve Lending, and had the Fed not cut interest rates to absurd levels while fostering a “too big to fail” attitude at banks, this would not have happened. Perpetual Congressional budget deficits and the Fed’s willingness to finance those deficits too cheaply is icing on the “what happened” cake.
which comports more closely with the actual meaning of a cause as things that are necessary and sufficient for something to occur.
Barry Ritholtz demurs; he’s got a longer, more involved explanation.
In my opinion to identify what caused the financial crisis you’ve got to consider fiduciary responsibility. When viewed through this lens Mish’s argument becomes all the stronger. The main culprit was the Congress which placed impossible burdens and mutually contradictory mandates on the Fed, the Fed for exhibiting overweaning arrogance, and Congress and regulators in conjunction for allowing fractional reserve lending to grow completely out of bounds.
I won’t absolve bankers of actual wrongdoing; details of this are coming out even now but I strongly suspect that actual wrongdoing was contributory rather than causal.
I’m not entirely convinced by the commission’s minority’s argument that regulation wasn’t a primary cause because the financial crisis wasn’t isolated to the United States. I think that the widespread character of the financial crisis merely demonstrates that banks are interconnected and that banking regulators are subject to the same temptations everywhere.
There are two forms of regulatory capture. In the first form those being regulated become de facto responsible for their own regulations: they write the rules, pick who their regulators will be, and decide what is or is not an infraction. The second form, cognitive capture, is even more insidious. In the case of cognitive capture those being regulated don’t need to write the rules because the regulators identify with those they’re tasked with regulating, consider their interests first, and are predisposed to tread lightly on them.
I think we suffer from both forms of regulatory capture and the only remedy is to change the incentives of regulators. Failing that we’ll merely repeat the errors of the past until the entire system collapses in an Argentina, Zimbabwe, or Weimar-style loss of confidence. Then, having wreaked fantastic misery, the entire merry minuet can begin again with a combination of old and new players.